Tri-party collateral management is an approach that evolved following the collapse of American securities firm Bevill, Bresler and Schulman in the mid-1980s. This company was essentially entering into repo agreements with more than one partner at once, using the same collateral for both transactions. When the company went bankrupt, the lenders realized that they had not been collateralized to the extent they had believed, leading to significant losses.
In order to prevent this type of scenario in the future, the U.S. Securities and Exchange Commission (SEC) introduced the concept of repo custodians, or management firms in charge of supervising collateral and all other aspects of the repo transaction. In addition to preventing fraud, this arrangement led to development in the collateral management industry. Custodian institutions found themselves in the position to create a market for repos, advertising assets being offered for collateral, as well as terms for the collateral, and connecting borrowers with lenders.
Tri-party collateral management also provides a variety of other benefits for borrowers and lenders. The custodian firm will conduct research into what kinds of assets constitute acceptable collateral for a given transaction, and they may require the borrower to diversify its collateral offer in order to offset risks. The operational risks of the transaction are also reduced, as the two parties involved do not need to provide the infrastructure to maintain the collateral or ensure the terms of the agreement are adhered to.
About the author: An expert in tri-party collateral management, James Glover developed many of the tools employed by RBS/Greenwich Capital for its repo transactions. He possesses over two decades of experience in finance.